European style debt crisis could happen here: MLI study

MEDIA RELEASE

OTTAWA, October 18, 2012 - Canadians shouldn't be complacent about the European debt crisis because several provinces are heading towards unsustainable finances in the medium and long term unless their policies change, a study commissioned by the Macdonald-Laurier Institute concludes.

Written by San Francisco credit expert Marc Joffe, the study found the situation raises "the spectre of debt crises, damaged credit ratings, and federal bailouts if corrective steps are not taken."

Setbacks like these would not only affect the provinces directly involved but the entire Canadian economy, Mr. Joffe added in the study, entitled Provincial Solvency and Federal Obligationsand available at the following link:

A key finding of the study was that long term bond rates paid by the provinces do not reflect their underlying creditworthiness, possibly because financial markets assume Ottawa would come to the rescue with a bailout in the event of any provincial default.

"Canadians may be surprised to learn which provinces pose the greatest systemic risk to public finances in Canada," said Mr. Joffe, formerly Senior Director at Moody's Analytics.

Alberta and Ontario are among those provinces. The MLI study found that Ontario has the highest probability of default at the 10, 15 and 20-year forecast terms. Alberta has the highest default probability at the 30-year threshold in the study's forecasting model even though it currently has the highest bond ratings and no net debt.

Joffe calculated the default probabilities based on the annual likelihood of provinces' reaching the critical fiscal threshold of an interest to revenue ratio of 25%.

In Ontario's case, this is due to high level of public debt – second only to Quebec in terms of percentage of GDP – and chronic deficits.

Alberta performs poorly at the 30-year threshold for three reasons:

- Like Ontario, Alberta is currently running high deficits. And like Ontario, those deficits are projected to persist.

- Statistics Canada projects that Alberta will experience more rapid growth in its senior citizens population than any other province. Since seniors rely more heavily on provincial health services, growth in this population component is likely to drive an explosion in medical expenditures.

- A significant portion of its revenue is derived from resource taxes, which are vulnerable to energy price volatility.

By contrast, StatsCan projects less growth in the senior populations of Quebec and Saskatchewan. These two provinces fare better in the 30-year forecasting period, with the lowest probabilities of default.

Although Quebec is currently running deficits, it has less dependence on volatile resource prices, Mr. Joffe said.

Overall, the study warned that by the end of the 30-year forecasting period, all provinces have high probabilities of default that range up to 84%. At the end of the 30 years, the economic benefit of today's low interest rates will most likely have disappeared.

Since all provinces currently have interest expense to revenue ratios of well below 25%, there is little probability of default anywhere in Canada in the short term, Mr. Joffe said. This gives the provinces ample time to change their fiscal stance by cutting spending and raising taxes, as they did during the 1990s. However, this time the challenges are more structural, originating in population ageing and slower growth.

All four Western Canadian provinces were insolvent during the Great Depression of the 1930s and Ottawa provided a rescue in each case. Newfoundland, then a sovereign dominion, needed a bailout from Britain and Canada.

The Macdonald-Laurier Institute is the only non-partisan, independent national public policy think tank in Ottawa focusing on the full range of issues that fall under the jurisdiction of the federal government. It initiates and conducts research identifying current and emerging economic and public policy issues facing Canadians.

Brent Beach

says on:

October 29, 2012 at 8:02 pm

I found the study very interesting. Having a detailed look at provincial debt that looks at the problem from all angles is very helpful.

However, the headline is a problem for me. The current EU crisis is a result of many causes, those cause differing from country to country. In few countries does the problem arise from the country having too much debt in the way Canadian provinces have debt.

Ireland - until the government took on the debt of its failed banks, banks which had failed because they financed a new housing boom, there was no problem. Spain is in trouble for similar reasons, with more complicity of the political class which benefited handsomely from it direct participation in the banking sector. Iceland - a failed banking model. France - again, a banking model in which its banks were able to treat EU sovereign debt as riskless.

Even in the case of Greece, the debt problem is a corruption problem and an inability to collect taxes. Neither of those problems apply now, nor will they apply in the time frames of this study, in any of the provinces (not even Quebec).

So, we have our own style of debt problem. Not one patterned on the EU, or the US.